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Shutdown vs. Default: The Relative Impact

At the moment, Congress is figuring out how to avoid two forms of chaos of its own making: a government shutdown and a public default.

The former might happen when the continuing resolution financing the federal government expires on Sept. 30. The latter might happen when the Treasury runs out of room under its statutory debt ceiling. That day — often called the X-date — is likely to come around Oct. 15.

In the past few weeks, we’ve heard lots of talk from Republicans and Democrats about who wants to stake what on which deadline. On Friday the House passed a bill that would continue funding the government while also defunding the Affordable Care Act. Some Republicans want to tie cuts to entitlement programs or a delay of the health coverage expansion to the debt ceiling. The White House has indicated its willingness to negotiate over government spending, but not over the debt limit.

Legislators are using both the debt ceiling and a continuing resolution as bargaining chips. But economists warn against reading any equivalence into the two: failing to raise the debt ceiling would be much, much, much worse for the economy, they argue, than a temporary shutdown.

What Would Happen?

To understand why, it helps to understand what would happen in a shutdown and what would happen in a default.

On Sept. 30, the continuing resolution channeling money to the various federal agencies would expire, and with it the government’s “spending authority.” Washington’s debit card would be cut off and the agencies would be ordered to stop racking up bills.

A shutdown would not affect “mandatory” spending — meaning money for Medicaid, Medicare, Social Security, unemployment insurance, food stamps, tax credits and a smattering of other programs. But it would put a vise on “discretionary” spending, meaning everything else, from national parks to the Education Department to visa offices. Hundreds of thousands of employees would be put on furlough, and much of the federal government would go offline.

There are some exceptions. Self-financing agencies, like the Postal Service, would remain at work. So would activities with a “reasonable and articulable connection between the function to be performed and the safety of human life or the protection of property.” That means air traffic control, food inspection, federal prisons, disaster assistance, border security and veterans’ hospitals.

On the X-date, on the other hand, the Treasury would find itself unable to make all that day’s federal payments.

To be clear, that is not “hitting the debt ceiling.” That happened on May 19. The government has stayed about $25 million below the $16,699,421,000,000 limit since then through various “extraordinary measures” that have let it free up about $300 billion in cash. But those “extraordinary measures” cannot last forever. One day — sometime in late October, probably, though nobody knows exactly when — cash going out would overwhelm cash coming in plus cash on hand. The government would keep missing payments, about 30 percent of them, until Congress raised the debt ceiling again.

The Uncertainty

So why would the X-date be worse than a shutdown? One main reason is uncertainty.

The various federal agencies and departments are required to keep contingency plans in case of a shutdown. (You can read all of them here.) Sylvia Mathews Burwell, the White House budget director, sent the agency heads a letter last week, reminding them to update their plans and get ready.

A shutdown would be very inconvenient for those trying to, say, get a visa, be hired or paid by a federal department, or walk the Continental Divide. But it would be orderly in Washington. Employees would know whether to head in to work or not. Critical functions would remain online. The markets might not like it. But they probably would not panic, either.

It is also worth noting that a shutdown would not be unprecedented. Congress has been threatening to have one for years now. And the last one occurred about halfway through the Clinton administration, giving an idea of the practical and economic impact.

Not so if Congress failed to raise the debt ceiling before the X-date. There is really no playbook there. It is not certain when it would happen. It is not clear what payments would be missed. The Treasury makes more than 80 million of them a month, after all.

The best information comes from this Treasury inspector general report last year. It indicated that the Treasury Department had rejected the idea of cutting all payments across the board, to keep money going out equal to money coming in. “Prioritizing” payments — paying bondholders first, for instance — might be difficult, given that the Treasury payment systems are not built to do so and there is no legal argument for doing it. Delaying payments would be the preferred option, the report indicates. But there is nothing like an agency-by-agency plan.

In response, the financial markets would probably panic. They might not. Some financial experts argue that a few missed payments that spurred immediate Congressional action to lift the ceiling might not be so bad. But many, many others foresee a financial tsunami that would raise the country’s borrowing costs, send investors scrambling for safety and deeply injure the United States and global economy.

The Costs

There is no real comparison between the cost of a shutdown and the cost of a breach in the debt ceiling.

The two shutdowns of the Clinton years — a six-day shutdown in 1995 and a 21-day shutdown between 1995 and 1996 — cost about $1.4 billion. A more complete accounting suggests that is on the low side. Nevertheless, employees and contracts would eventually be paid. Spending by the public that did not go to national parks might go to state parks instead. The damage would be fairly minimal in the context of a $16 trillion economy, especially if the shutdown were short.

In contrast, a breach of the debt ceiling and the ensuing market gyrations might cost hundreds of billions, perhaps more.

For one thing, it would raise the United States’ borrowing costs, with investors demanding more in exchange for their cash. How much more, we do not know. But a 0.5 percentage point increase in Treasury rates — from 3 percent to 3.5 percent, for instance — would eventually cost about $75 billion a year.

That would be bad enough. But the related costs to the economy would be far, far worse. The price tag on a huge range of other debt products is benchmarked to the cost of Treasuries. That means a spike in the federal government’s borrowing costs would translate into pricier mortgages, car loans and corporate borrowing costs. And that means a slower recovery.

There would be other second-order effects too. Investors dumping stocks and fleeing to cash might depress business confidence and depress the wealth effect of the recent run-up, for instance. International markets would feel the pain too.

It might not even take reaching the X-date for the government to see higher costs related to the debt ceiling, either. The Government Accountability Office has estimated that the debt ceiling showdown of 2011 cost taxpayers $1.3 billion in that fiscal year alone. The Bipartisan Policy Center pegs the cost at $18.9 billion over 10 years.

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